As I recently mentioned, I just took out a loan to buy stocks. Right now, interest rates are temptingly low, and while the U.S. market overall is expensive, there are still undervalued companies there and elsewhere that can overcome the loan's interest rate cost.
My impression is that few people do this. Stocks are risky, and those who lever up can flame out hard. Stocks, in addition to being volatile, are nearly always available to be traded. I could get drunk, get scared at falling prices on my iPhone, and close every position in my portfolio at a giant loss with six or seven taps. Applying leverage to that is risky, no doubt, and buying stocks on leverage attracts a certain amount of skepticism and disdain.
Real estate leverage attracts much less scrutiny.
Stating the obvious, the high price of a single real estate unit usually requires a buyer to finance the purchase through a mortgage or other lending structure. That's naturally as true in Germany as in the US. And that leverage means, theoretically, that you can turn your down payment into a much more potent force, where you can reap the levered gains from rent and from the price appreciation.
For those who do this, it's possible that rental income more than covers the monthly cost of the mortgage. Indeed, one of the oft-repeated strikes against renting is, "You're paying someone else's mortgage." For a landlord who accomplishes this repeatedly, they can create an empire of rental units paying off his or her debts all while accumulating value through appreciation.
It sounds like a dream.
Expensive
In Germany however, it looks much less dream-like. To be fair, there are serious real estate investors here. I know two of them personally, and their wealth is absolutely real. But recently, both have said the same thing: everything's too expensive.
For all the complaints about costs in the US, German real estate feels increasingly out of reach. Yes, if you live in the hot American cities, purchasing real estate can be nigh impossible. But even in the not-so-hot German cities, buying an apartment can be a ludicrous amount of money for what you get.
Prices in many cases have outstripped the possible rental income you can get from the property. I sometimes see properties listed with a renter in place. That means the rental income starts immediately without having to go through the hassle of finding a tenant and doing all the necessary background checks.
But if you do the math it stops seeming so nice. I've gone through the listings and priced out mortgages for given down payments to see what kind of cash flow can come from these properties, and it doesn't work. In general, the down payment would have to be enormous for the property to have positive cash flow from the rental income. But having an enormous down payment cancels out the benefits from the low interest rates in the first place.
Tenant Protections
For an American, you might ask, "Why not just raise rents?" But we're not in Kansas anymore, and there are legal and cultural realities you have to adapt to. In general, German renter protections are much higher. And, as a renter, they're great.
Leases are continuous, and the renter can leave at any point if they notify the landlord 90 days in advance. So there's no new lease signing event to hike rents. Instead, there are prescribed rules about when and by how much a landlord can raise rent on an existing tenant, and it's biased in favor of the tenant. For the ambitious landlord, there are ways to force it, such as by doing a large Modernisierung of the unit where it's materially nicer and more energy efficient and therefore deserving of higher rents. But that's yet another cost, and do you really want to spend your time doing that?
Dealing with tenants, by all accounts, is hard in Germany. One of my landlord friends says that you basically can't raise rents once a tenant is in place. Kicking tenants out who don't pay rent is, by all accounts, difficult and lengthy. In addition, tenants are allowed to lower their rent payments for cause, such as loud construction nearby. German renters have non-profit organizations that can go to fight for them for nominal membership fees.
High Taxes and Fees
If you're versed in basic investing wisdom, you know that keeping fees low is a primary requirement of the wise investment. But for the German real estate investor, taxes and fees are deadly. When you buy an Immobilien in Germany, you pay a series of up-front fees that are an immediate loss.
If you visit a site like ImmobilienScout24, they list fee estimates for a given property. For example, the estimated fees for an apartment in Stuttgart is around 10-11%. That includes the following:
- Maklerprovision (3.57%, broker fee, and the one fee that can be avoided)
- Grunderwerbsteuer (5%, property transfer tax)
- Notarkosten (1.5%, lawyer fees)
- Grundbucheintrag (.5%, registration fee)
So in my Stuttgart example, according to Sparkasse's calculator, we get an estimate of €50,350 in Nebenkosten.
Here's an actual example in Stuttgart from a 56m2 (about 603 sq. ft) Maisonette apartment with slanted walls with a property price of €298,000 where the Nebenkosten add up to €27,952, which equals a total cost of €325,952. And that's with a slightly lower Maklerprovision.
To be sure, the fees vary depending on location. The Maklerprovision and the relevant taxes depend on the local government rules. But they're all high, and the fees are purchase price dependent. The Maklerprovision gets a lot of hate despite it being the one fee that is sometimes avoidable, but the Grunderwerbsteuer by itself will bite you hard. With property values at high levels, you're getting hit twice: you're at higher risk of a fall in property values, and you're hit by the upfront fees attached to that price1.
You're also guaranteeing yourself high opportunity cost. You'll have to save up those fees since banks generally won't finance them for you. To save up, you'll likely stick the money in a savings account earning nothing, and it might take years. You have to ask yourself if the lost potential gains in the stock market are worth it. If it takes you two years, those are two years of compounding you never get back. And when you eventually buy, your down payment might go entirely to the fees and not towards the property, leaving you financing 100% of the property value.
Those fees mean that there's never a guarantee that you earn any money from the purchase. It's an immediate hit of ~6-12% up front of the levered cost, and if you're compelled to sell for any reason before compounding has overcome that hurdle, then it's a shocking loss of potentially more than your entire down payment. That's the two-edged sword of leverage.
At the very least, it means that you'd better be damned sure that this is the best use of your money or that you have some special insight or strategy that makes those costs worth it. And you'd better be able to hold on.
Property Tax
There is property tax (Grundsteuer) here in Germany, but trying to estimate it in advance is hard. Just know this: you will have ongoing property taxes. They are not particularly onerous, which is one advantage compared to the US.
What I've divined from the online literature is this: the tax varies based on the type of dwelling and depends on an official value assessment (Einheitswert) by the state (Bundesland) you're in. This number is much lower than the purchase price and gets adjusted every six years. That number is multiplied by a small percentage (Steuermesszahl). This value is then multiplied by several hundred percent (Hebesatz) - depending on the state - to equal your yearly tax. Clear?
Expat Issues
I haven't even talked about the potential challenges of being a U.S. expat doing this. For one example, Robert Kiyosaki likes to extol the virtues of not owning anything yourself to protect yourself from liability issues and lawsuits. That would likely mean putting your properties into a corporation or other such entity. But you, the American expat, have to consider the implications back in the States and what the IRS will make of your German arrangements. Controlled foreign corporations require extra compliance and paperwork.
There's also the rule that the IRS can declare that you have capital income from your mortgage if the exchange rate changes in your favor.
Lastly, there are the normal challenges of being a real estate investor that exist everywhere. All the stuff listed above is layered on top of that already substantial levered risk burden.
High Prices, Lots of Rules, High Fees, the IRS... What's Not to Like?
If you're excited by real estate, and other options won't do, then more power to you. There are likely unexplored riches because the hurdles are so high, and there are likely strategies that can work for those geniuses who recognize and execute on them. If you're actually receiving cash from your purchase in excess of your outflows, it dulls - but doesn't eliminate - the impact of the up front fees, especially compared to owning a home as a residence.
But at this moment, I can type some numbers into my computer, get an appropriately-sized loan relative to my income, buy a diversified basket of stocks, and go on with my life. If that sounds irresponsible to you, you have to ask if losing potentially tens or hundreds of thousands of euros up front guaranteed for a likely overpriced asset to service tenants whom you can't kick out sounds responsible.
Maybe neither sounds responsible, and that, at least, would be consistent. But I want to use low interest rates to my advantage, and although I'm attracted to real estate, I look at the reality of it and am turned off in comparison to other options.
Does that mean never for this oft confused expat? Of course not. I've moderated my opinions often, even after writing negative articles. Buying stuff is fun, and property captures my imagination. I know all this because I regularly stare at property listings, after all. But there's a lot of friction in buying real estate, and I assume that I'd bail before putting my name on the dotted line.
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In comparison to the US, Bank of America estimates the closing costs for a $500,000 property in Charlotte, NC with a 5% down payment at $12,921. In New York City, it'd be $21,547.↩︎
